Notice To Members 86-81

Amendments to Appendix F Regarding Freely Tradable Partnership Units Effective Immediately

Published Date:

TO: All NASD Members and Other Interested Persons

ATTN: Direct Participation Programs Department

EXECUTIVE SUMMARY

This notice announces the adoption of exemptions from the special suitability and disclosure requirements of Appendix F to Article III, Section 34 of the NASD Rules of Fair Practice for freely tradable limited partnerships. The exemptions relate to primary and secondary public offerings of and secondary market transactions in freely tradable partnership units, depositary receipts or assignee units quoted on the NASDAQ System or listed on a registered national securities exchange.

The NASD has adopted amendments to Sections 3 and 4 of Appendix F to Article III, Section 34 of the NASD Rules of Fair Practice, which are effective immediately. The text of the amended sections is attached.

The amendments provide exemptions for primary and secondary offerings and secondary market transactions in direct participation program securities from the suitability provisions contained in Section 3 and the requirement in Section 4 that NASD members inform potential investors of the facts pertaining to the lack of liquidity and marketability of the program securities.

BACKGROUND

Appendix F was adopted for the purpose of regulating the distribution of and secondary transactions in direct participation program securities. These securities are usually partnerships and have traditionally been illiquid. Investors are generally required to hold an investment in a direct participation program for a number of years in order to fully realize the benefits of the investment. The nature of a direct participation program security, therefore, presents special concerns regarding its suitability for investors, the adequacy and accuracy of the disclosure in the offering document, and other program arrangements that Article III, Section 34 and Appendix F, adopted thereunder, were intended to address.

Recently, however, an increasing number of direct participation programs have issued partnership units, depositary receipts for such units, or assignee units of limited partnership interests that are freely tradable in a manner generally analogous to common stocks and are quoted on the NASDAQ System or listed on registered national securities exchanges. Therefore, the NASD undertook a review of the application of Appendix F to freely tradable program units.

Subsection 3(a) of Appendix F prohibits a member from distributing a direct participation program that has not established or disclosed in the program prospectus standards of suitability. Subsection 3(b) of Appendix F requires members, when "recommending the purchase, sale or exchange of an interest in a direct participation program," to obtain certain enumerated information, make an affirmative finding of suitability, and retain a record of the basis for that finding. These requirements were specifically included in light of the absence of liquidity in the market for limited partnerships, as well as to assure that the unique tax status and investment characteristics of the program are considered in secondary market transactions, and in initial distributions.

The NASD has reviewed the purposes of the special suitability requirements contained in subsections 3(a) and 3(b) of Appendix F and has concluded that these special requirements are not necessary for freely tradable program units. It is important to note, however, that transactions in freely tradable partnership units remain subject to the general suitability requirements of Article III, Section 2 of the NASD Rules of Fair Practice.

Subsection 4(d) of Appendix F requires NASD members to inform potential investors of the facts relating to the lack of liquidity and marketability of investments in direct participation programs prior to the execution of such transactions. Compliance with this subsection is unnecessary where an active trading market exists or will exist for the program units.

SUMMARY OF AMENDMENTS

The NASD has amended subsections 3(a) and 3(b) and subsection 4(d) of Appendix F to exempt from those provisions:

(1) secondary offerings of or secondary market transactions in a direct participation program security for which quotations are displayed on the NASDAQ System or which is listed on a registered national securities exchange; and
(2) primary offerings of direct participation programs for which an application for inclusion on the NASDAQ System or listing on an exchange has been approved.

In addition, with respect to primary offerings, the new exemption requires the issuer to make a good-faith representation that inclusion on the NASDAQ System or listing on a registered national securities exchange will occur within a reasonable period of time following the formation of the program.

Questions regarding this notice should be directed to the NASD Corporate Financing Department at (202) 728-8258.

Sincerely,

Frank J. Wilson
Executive Vice President
Legal and Compliance

Attachment

AMENDMENTS TO APPENDIX F ARTICLE III, SECTION 34 NASD RULES OF FAIR PRACTICE*

* * * *

Section 3

Suitability

(a) A member or person associated with a member shall not underwrite or participate in a public offering of a direct participation program unless standards of suitability have been established by the program for participants therein and such standards are fully disclosed in the prospectus and are consistent with the provisions of subsection (b) of this section.
(b) In recommending to a participant the purchase, sale or exchange of an interest in a direct participation program, a member or person associated with a member shall:
(1) have reasonable grounds to believe, on the basis of information obtained from the participant concerning his investment objectives, other investments, financial situation and needs, and any other information known by the member or associated person, that:
(i) the participant is or will be in a financial position appropriate to enable him to realize to a significant extent the benefits described in the prospectus, including the tax benefits where they are a significant aspect of the program;
(ii) the participant has a fair market net worth sufficient to sustain the risks inherent in the program, including loss of investment and lack of liquidity; and
(iii) the program is otherwise suitable for the participant;
(2) maintain in the files of the members documents disclosing the basis upon which the determination of suitability was reached as to each participant.
(c) Subsections 3(a) and 3(b) shall not apply to:
(1) a secondary public offering of or a secondary market transaction in a unit, depositary receipt or other interest in a direct participation program for which quotations are displayed on the NASDAQ System or which is listed on a registered national securities exchange, or
(2) an initial public offering of a unit, depositary receipt or other interest in a direct participation program for which an application for inclusion on the NASDAQ System or listing on a registered national securities exchange has been approved by NASDAQ or such exchange and the applicant makes a good-faith representation that it believes such inclusion on NASDAQ or listing on an exchange will occur within a reasonable period of time following the formation of the program.
[c]
(d) Notwithstanding the provisions of subsections (a) and (b) hereof, no member shall execute any transaction in a direct participation program in a discretionary account without prior written approval of the transaction by the customer.

Section 4

Disclosure

* * * *

(d) Prior to executing a purchase transaction in a direct participation program, a member or person associated with a member shall inform the prospective participant of all pertinent facts relating to the liquidity and marketability of the program during the term of the investment[.]; provided, however, that this subsection shall not apply to an initial or secondary public offering of or a secondary market transaction in a unit, depositary receipt or other interest in a direct participation program which complies with subsection 3(c).

* New language is underlined; deleted language is in brackets.